Making Stuff

May 5, 2019

by Steve Stofka

This week I’ll review several decades of trends in productivity. How much output do we get out of labor, land, and capital inputs? Capital can include new equipment, computers, buildings, etc. In the graph below, the blue line is real GDP (output) per person. The red line is disposable (after-tax) income per person. That’s the labor share of that output after taxes.

As you can see, labor is the majority input. In the following graph is the share of real GDP going to disposable income.  In the past two decades, labor has been getting a larger share.

That might look good but it’s not. Since 2000, the economy has shifted toward service industries where labor does not produce as much GDP per hour. The chart below shows the efficiency of labor, or how much GDP is being produced by labor.

If labor were being underpaid, the amount of GDP produced per dollar of disposable income would be higher, not lower. On average, service jobs do not have as much leverage as manufacturing jobs.

A century ago, agricultural jobs were inefficient in comparison to manufacturing jobs. The share of labor to total output was high. In the past seventy years, the agricultural industry has transformed. Today’s farms resemble large outdoor manufacturing plants without walls and productivity continues to grow. In the past five years, steep price declines in the prices of many agricultural products have put extraordinary pressures on today’s smaller farmers. The increased productivity of larger farms has allowed them to maintain real net farm income at the same level as twenty years ago (Note #1). Here’s a graph from the USDA.

Although agriculture related industries contribute more than 5% of the nation’s GDP, farm output is only 1% of the nation’s total output. The productivity gains in agriculture have not been shared by the rest of the economy. Labor productivity has plunged from 2.8% annual growth in the years 2000-2007 to 1.3% in the past eleven years (Note #2).  Here’s an earlier report from the Bureau of Labor Statistics with a chart that illustrates the trends (Note #3). The report notes “Sluggish productivity growth has implications for worker compensation. As stated earlier, real hourly compensation growth depends upon gains in labor productivity.”

Productivity growth in this past decade is comparable to the two years of deep recession, high unemployment and sky-high interest rates in the early 1980s. The report notes “although both hours and output grew at below-average rates during this cycle [2008 through 2016], the fact that output grew notably slower than its historical average is what yields the historically low labor productivity growth.” Today we have low unemployment and very low interest rates – the exact opposite of that earlier period. Why do the two periods have similar productivity gains? It’s a head scratcher.

Simple answers? No, but hats off to Donald Trump who has called attention to the need for a greater shift to manufacturing in the U.S. economy. He and then Wisconsin governor Scott Walker negotiated with FoxConn Chairman Terry Gou to get a huge factory built in Mount Pleasant, Wisconsin to manufacture LCD displays, but progress has slowed. An article this week in the Wall St. Journal exposed the tensions that erupt among residents of an area which has made a major commitment to economic growth (Note #4).

If we don’t shift toward more manufacturing, American economic growth will slow to match that of the Eurozone. Along with that will come negative interest rates from the central bank and little or no interest on CDs and savings accounts. We already had a taste of that for several years after the recession. No thanks. Low interest rates are a hidden tax on savers. They lower the amount of interest the government pays at the expense of individuals who are saving for education or retirement. Interest income not received is a reduction in disposable income and has the same effect as a tax. Low interest rates encourage an unhealthy growth in corporate debt and drive up both stock and housing prices.

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Note:

  1. USDA summary of agricultural industry
  2. BLS report on multi-factor productivity
  3. BLS report on declining labor productivity
  4. FoxConn LCD factory (March article – no paywall). Also, a recent article from WSJ (paywall) – Foxconn Tore Up a Small Town to Build a Big Factory—Then Retreated

A Real Minimum Wage

November 18, 2018

by Steve Stofka

Near the top of the Democratic agenda in the new Congress is a minimum wage of $15. The bill is unlikely to pass the Senate, but it will signal to the voters that the Democratic House is meeting campaign promises. The states with the most solid Democratic support are those on the west coast and northeast coast where the cost of living is much higher. A single minimum wage for the entire country is not appropriate. Republicans control the Senate and they are from states with much lower costs of living. They will reject an ambitious minimum wage that is one-size fits all.

Housing is the largest monthly expense for most families. Below is a graph of home prices in several western metropolitan areas (MSAs) and the national average of twenty large MSAs. Home prices in Dallas and Phoenix are a 1/3 less than Los Angeles and San Francisco. Housing costs in many smaller cities will be below Dallas and Phoenix.

CaseShillerComps

Why isn’t the minimum wage indexed to inflation? Because politicians of both parties, but particularly Democrats, have used it as a wedge issue to gain voter support. If the House Democrats wanted to pass bi-partisan legislation on a minimum wage, they could use a flexible minimum wage that is indexed to the average wages for each region within the country. These are published regularly by the Bureau of Labor Statistics, the same agency that publishes the monthly report of job gains and the unemployment rate. I’ve charted the annual figures for those same cities.

HourlyEarnComp

A $15 minimum wage is 40% of the average wage in San Francisco, and a bit more than half of the average wage in Los Angeles. It is almost 60% of the national average. The current minimum of $7.25 is 28% of the national average.

If the House passed a minimum wage bill that set the wage to 40% of the average wage for each region, Senate Republicans might at least consider it. In Denver and L.A., the minimum wage would be about $11.50. In Dallas and Phoenix, it would be about $10.60. Democrats could show that they are in Washington to pass legislation for working families, not pound some ideological stump as Republicans did for eight years with the repeal of Obamacare.

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Stocks and Taxes

There is a close correlation between stock prices and corporate tax collections. The tax bill passed last December lowered corporate tax revenues in the hope that businesses would invest more in the U.S. The divergence between prices and collections has to correct. Either tax collections increase because of greater profitability or stock prices come down.

StocksVTaxes
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Income Growth

The financial crisis severely undercut income growth. Real, or inflation-adjusted, per capita income after taxes decreased for three years from 2008 through 2010, and again in 2014. It is the longest period of negative growth since the 1930s Depression.

IncomeRealPerCapGrowth

High Optimism

June 18, 2017

Last week I looked at two simple rules: 1) don’t bet on which chicken will lay the most eggs, and 2) don’t put all your eggs in one basket. This week I will look at index averages and I promise I won’t mention chickens.  Lastly, I will look at a metric that disturbs me.

When I first started investing in Vanguard’s SP500 index mutual fund VFINX, I thought I was buying the average performance of the top 500 companies in America. Like many index funds, VFINX is weighted by market capitalization. With this methodology, a relatively small number of companies have more influence on the movement in the index than their numbers might warrant.

Let’s turn to Vanguard’s breakdown of the top ten stocks in their VFINX fund. These ten stocks are household names, including Apple, Microsoft, Google (Alphabet), Amazon, and Facebook. These five tech stocks are 1% of the 500 companies in the index but make up 13% of the fund. The ten companies make up 20% of the fund.

For investors who want to cast a wider net, there is an alternative: equal weighted funds. Guggenheim’s RSP is an equal weighted ETF first offered in 2003. Using Portfolio Visualizer, I started off in 2004 with $100,000 and invested $500 a month. Despite the higher expense ratio, RSP had a better return, besting a conventional market cap index by 1% annually.

VFINXVsRSP

Why does RSP outperform VFINX?  Funds that mimic the SP500 are heavily weighted to large cap stocks. Equal weight funds have a greater percentage of mid-cap companies which may outperform large caps in a particular decade but that outperformance may come at a price: volatility.

Standard deviation is a statistical measure of the zig and zag of a data series, like measuring how much a drunk veers as he stumbles along his chosen path. The standard deviation (Stdev column above) of RSP is slightly higher than VFINX, and the maximum drawdown of RSP is almost 5% higher during the 2008-2009 financial crisis.  The Sharpe ratio is a measure of risk adjusted return, and the higher the better. As we can see in the Sharpe column, the two strategies are within a few decimal points.  In the past 13 years, an equal weighted strategy produced higher returns with only a slightly higher risk.

If I want to mimic some of the diversity of an equal weight index, I can spread out my investment dollars among large-cap, mid-cap and small-cap funds. As SP500 index products, neither RSP or VFINX includes small cap stocks, but let’s add a small percentage into our mix.

Into my comparison of strategies, I’ve added a portfolio with a 40% allocation to VFINX, 40% to VIMSX, a mid-cap Vanguard index fund, and 20% to VISVX, a Vanguard-small cap value index fund. The performance is almost as good as the equal weight RSP and the Sharpe ratio, or risk adjusted return, is similar.

VFINXVsRSPVsMix

In 2011, Vanguard published an analysis (PDF) of various approaches to indexing that may be of interest to those who want to dive into the topic.

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Household Net Worth

Let’s turn from indexing strategies to stock market valuation. We base our expectations of the future on the recent past. Those expectations are the primary driver of valuation. If we expected an affordable self-driving car in the next few years, the current value of today’s cars would be lower.

I have written before about a store of value compared to a flow of value. Savings are a store of value. Income is a flow. The historical ratio of wealth (store) to income (flow) reveals a trend that should give us caution.  The Federal Reserve charts estimates of  both household wealth and disposable income. The current ratio of wealth to income is now higher than the peaks in 2006 and 2000 when the real estate and dot-com booms inflated wealth valuations.

HouseholdNetWorthPctIncome

The current ratio is far above the 70 year average but a moving ten year average of the ratio may better reflect trends in investment allocation over the past few decades. Using this metric, today’s ratio is still very high. Rarely does the wealth-income ratio vary by more than 10% from its 10 year average.

When the wealth-income ratio dips as low as 90% of its ten year average, extreme pessimism reigns, as in the early 1970s.  A ratio that is 10% more than the ten year average indicates extreme optimism as in the late 1990s, mid-2000s and now. Today’s ratio is 13% above its ten year average.

In early 2000, the ratio was 16% above its ten year average when the enthusiasm of dot-com expectations began to deflate and the price of the SP500 fell from its lofty heights. The ratio reached 14% above its ten year average in 2005 and remained above 10% till mid-2007 when the first cracks in the housing crisis began to surface and the SP500 said goodbye to its peak.

A picture is worth a 1000 words so here’s a chart of the Household Wealth to Income ratio divided by its ten year average. I have highlighted the periods of extreme pessimism and optimism.

HouseholdWealthRatio10Year

If history is any guide, the ratio of wealth to income can stay elevated for a few years. The “haves” keep trading with each other in a game of muscial chairs until people begin to leave the game and move their dollars into other assets, other markets, or bonds and cash. Unfortunately, many slow moving casual investors are left in the game with deteriorated portfolio values.

Economist Robert Shiller, author of Irrational Exuberance and developer of the long term CAPE ratio, recommended a strategy of shifting allocation in response to periods of exuberance and pessimism.  When valuations were historically low or average, an investor might allocate 60% or more of their portfolio to stocks.  As valuations became overextended, an investor might shift their stock allocation to 40%.  The investor is not trying to predict the future. The portfolio remains balanced but the stock and bond weights within the portfolio changes.

Using this wealth-income ratio as a guide, the casual investor might gradually implement an allocation shift toward safety in the coming year.

Inauguration 2017

January 22, 2017

Mr. Trump’s inauguration marks the first time in almost a hundred years that a business person assumes the highest political position in the country.  His cabinet choices share that same characteristic. There will be an inevitable clash of cultures.  Many civil servants are lifers, drawn to the generous benefits of government service, and the stability of employment.  Some may be drawn to the work because it gives them a sense of self-worth.

Many have little experience in private industry and distrust the motives of business owners.  Former President Obama was one of these.  An inspirational figure to some, his antipathy to business interests of all sizes antagonized political foes who challenged him for most of his two terms.

Mr. Trump has a similar weakness – his antipathy to and unfamiliarity with the insular culture of civil servants who work in a massive bureaucracy characterized by a thicket of rules and a lack of transparency.

Work in the private sector is characterized by competition, a striving for efficiency, the changing winds of people’s preferences, and the quality of the services and products we provide.  Employment in the public sector requires patience with burdensome procedure, a tolerance of a heirarchy of both the competent and the undeserving, and a willingness to work in a system that relies less on merit and more on seniority.

What will happen when these two diametrically opposed cultures mix?  Stay tuned.

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Obamacare Kaput?

Since FDR began the custom, Presidents have signed executive orders on their first day in office to signify that they are on the job for that portion of the American electorate that put them in office.  One of the highlights of Mr. Trump’s campaign was the repeal of Obamacare.  Shortly after his inauguration President Trump signed an order stating his intention to repeal the ACA.  The order freezes any further promulgation of rules and regulations pertaining to the act.   I thought it would be appropriate to republish a blog I wrote in April 2011, a year before the Supreme Court ruled that most of the ACA was constitutional.  Like Social Security, ACA premiums and penalties were a tax.

The problems of providing health care and the insuring of that care have not gone away: rising costs, more sophisticated and expensive therapies, more demand for care from an aging population.  The problem is a knotty one:  how to distribute health care costs.  We all benefit from the availability of medical resources, yet these resources are very expensive.  The 24 hour care and equipment that stays idle in an urban hospital must be paid for with funds from other parts of the health care system.

It might surprise readers that more than 50% of the $3.5 trillion in Federal outlays is for Social Security benefits ($930B), Medicare ($600B) and Medicaid and Community health programs ($500B).  Eighty years ago, FDR initiated a new role for the Federal Government: an economic support system. To do that, FDR had to threaten and cajole a Supreme Court reluctant to stretch the meanings of several clauses in the Constitution.

Even FDR would be appalled to learn that the Federal Government has become an insurance company whose chief function is the collection of insurance premiums through taxes in order to pay insurance claims in the form of Social Security, Medicare and Medicaid Benefits.

Readers who would like to read more on a pie chart breakdown of government spending can visit the Kaiser Family Foundation’s fact sheet. Dollar amounts are from the latest White House budget.

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MM Bash

I’m about to bash criticize some of the reporting in mainstream media (MM) publications, whose budgets rely on viewership.  When that audience was more predictable, flagship publications like the NY Times, Washington Post and Wall St. Journal could wait to verify facts before running a story.  In the current 24 hours news cycle and the rush to print, fact checking sometimes comes after the story is published online – if at all.

MM channels rested on their decades old reputations for thorough journalism and were willing to cut off at the knees any reporter compromising that reputation.  More than a decade ago, Dan Rather lost his anchor job with CBS for running with a story about George Bush that had not been properly vetted. News (fact-checked) and opinion (not checked) were clearly defined when they were in separate sections of the newspaper. In this new age when most information is delivered digitally, we are quoting blogs or other opinions that are not fact checked as reputable news sources without verifying the information.

A lie travels around the world by the time the truth gets its boots on. Something like  that.  In today’s lightning fast world of information flow, an apocalyptic news item that can move markets can be tweeted, webbed, facebooked, and retweeted.  “China fires on U.S. destroyer in South China sea!”  “N. Korean missle hits Alaska!” Sell, sell, sell, buy, buy, buy signals can flash instantly to world markets.

Later, it’s no, China didn’t fire on a U.S. destroyer.  China said it would fire if fired on by a U.S. vessel in the S. China Sea.  No, the North Koreans didn’t actually fire a missle.  Instead they said that they had a missle that could fire a nuclear payload on Alaska.  They’ve been saying that for several years.  Most defense analysts remain skeptical.  Oops, nevermind stock and bond markets.

We can not prevent this, nor can we hide our savings under a mattress.  We can prepare by making sure that we have some emergency funds in place.  Most financial advisors recommend six months replacement income.  Only after those funds are in place should we consider that boat we want on Craigslist or the down payment on that house we want to flip.  Don’t just plan to have a plan.  Have a plan.

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Household Net Worth Ratio

The zero interest rates for the past eight years are not natural and have created distortions in business and residential investment as well as stock market valuations. Let’s look at the residential side of the picture.  Below is a sixty year chart of the percentage of household net worth to disposable income.

The majority of the net worth of households is in their home.  The value of stocks and bonds comes second.  One or both of the two factors in that ratio is mispriced.  Perhaps disposable income has not grown to match the growth in asset valuations.  When reality doesn’t match predictions for a time, assets reprice.

What affects the pricing of these assets? The stock market rises on the prospect of sales and profit growth.   Salaries and wages rise as businesses compete for workers in a faster growing marketplace.  Disposable income rises.  Home prices rise on the prospect that more workers can afford to buy a home.

Now, what happens when disposable incomes, the divisor or bottom number in this ratio, don’t rise as much as predicted?  Yep, the ratio goes up, just as it did in 1999-2000 and 2006-2008, the peaks in the graph.

New Year Review

January 3, 2016

As we begin 2016, let’s take a look at some trends.  It is often repeated that the recovery has been rather muted.  As former Presidential contender Herman Cain once said, “Blame Yourself!”  You and I are the problem.  We are not charging enough stuff or we are making too much money. Debt payments as a percent of after tax income are at an all time low.

At its 2007 peak, households spent 13% of their after tax income to service their debt.  Currently, it is about 10%. In early 2012, this ratio crossed below the recession levels of the early 1990s.  By the end of 2012, this debt service payment ratio had fallen even below the levels of the early 1980s.  Almost six years after the official end of the Great Recession the American people are behaving as though we are still in a recession.  An aging population is understandably more cautious with debt.  In addition to that demographic shift, middle aged and younger consumers are cautious after the financial crisis. We gorged on debt in the 1990s and 2000s and paid the price with two prolonged downturns.  Having learned our lessons, our overactive caution is now probably dragging down the economy.

In this election year, we can anticipate hearing that the sluggish economy can be blamed on: A) the Democratic President, or B) the Republican Congress.  It is Big Government’s fault.  It is the fault of greedy Big Companies.  Someone is to blame.  Pin the tail on the donkey.  Blah, blah, blah till we are sick of it.

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Auto Sales

The latest figures on auto sales show that we are near record levels of more than 18 million cars and light trucks sold, surpassed only by the auto sales of February 2000, just before the dot com boom fizzled out.  On a per capita basis, however, car sales are barely above average.  The thirty year average is .054 of a vehicle sold per person.  The current sales level is .056 of a car per person.  Automobile dealers would have to sell an addiitonal 900,000 cars and light trucks per year to have a historically strong sales year.

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Construction Spending

In some cities, housing prices and rents are rising, and vacancies are low.  We might assume that construction is booming throughout the country.  Six years into the recovery per capital construction spending is at 2004 levels and that does not account for inflation.  Levels like this are OK, not good, and certainly not booming.

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Employment

The unemployment rate and average hourly wage may get most of the public’s attention but the Federal Reserve compiles an index of many indicators to judge the health of the labor market.  Positive changes in this index indicate an improving employment picture.  Negative changes may be temporary but can prompt the Fed to take what action it can to support the labor market.  Recent readings are mildly positive but certainly not strong.

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Stock Market

Many of the companies in the SP500 generate half of their revenue overseas.  Because of the continuing strength of the dollar, the profits from those foreign sales are reduced when exchanged for dollars.  According to Fact Set, earnings for the SP500 are projected to be about $127 per share, the same level as mid-2014.  In the third quarter of 2015, the majority of companies reported revenue below estimates.  As 4th quarter revenue and earnings are released in the coming weeks, investors will be especially vigilant for any downturns in sales as well as revisions to sales estimates for the coming year.  It could get bloody.

Merry Christmas

December 21, 2014

In preparation for today’s solstice, the market partied on in a week long saturnalia.  The week started off on a positive note.  Industrial production increased 1.3% in November, gaining more than 5% over November of 2013.

Capacity utilization of factories broke above 80%, a sign of strong production.  Production takes energy.  I’ll come to the energy part in a bit.

The Housing Market Index remained strong at 57, indicating that builders remain confident.  Tuesday’s report of Housing Starts was a bit of a head scratcher.  After a strong October, single family starts fell almost 6%.  Multi-family starts fell almost 10% in October, then rebounded almost 7% in November.  Combined housing starts fell 7% from November 2013.

The market continued to react to the change in oil prices.  For the big picture, let’s go back a few years and compare the SP500 (SPY) to an oil commodity index (USO).  For the past five years, USO has traded in a range of $30 to $40, a cyclical pattern typical of a commodity.  In October, the oil index broke below the lower point of that trading range.

On Tuesday, oil seemed to have found a bottom in the high $50 range.  USO found a floor at $21, about a third below its five year trading range.  Beaten down for the past three weeks, energy stocks began to show some life (see note below).

Encouraging economic news helped lift investor sentiment on Tuesday morning. Some bearish investors who had shorted the market went long to close out their short positions. Growth in China was slowing down, Japan was in recession, much of Europe was at stall speed if not recession and the continued strength of the U.S. dollar was making emerging markets more frail.  While the rest of the world was going to hell in a hand basket, the U.S. economy was getting stronger.  Thee Open Market Committee at the Federal Reserve, FOMC, began its two day meeting and traders began to worry that the committee might react to the strengthening U.S. economy with the hint at an interest rate increase in the spring of 2015.  This helped sent the market down about 2% by Tuesday’s close.

Wednesday’s report on the Consumer Price Index (CPI) was heartening.  Falling gas prices were responsible for a .3% fall in the index in November, lowering inflation pressures on the Fed’s decision making about the timing of interest rate hikes.  The core CPI, which excludes the more volatile energy and food prices, had risen 1.7% over the past year, slightly below the Fed’s 2% target inflation rate.  Traders piled back into the market on Wednesday ahead of the Fed announcement Wednesday afternoon.  Back and forth, up and down, is the typical behavior when investors are uncertain about the short term direction of both interest rates and economic growth.

The Fed’s announcement that they would almost certainly leave interest rates alone till mid-2015 gave a further 1% boost upwards on Wednesday afternoon.  Twelve hours later, the German market opened  up at 3 A.M. New York time.  Early Thursday morning, the price of SP500 futures began to climb, indicating that European investors were reacting to the Fed’s decision by putting their money in the U.S. stock market.  Those of you living in the mountain and pacific time zones of the U.S. might have caught the news on Bloomberg TV before going to bed.  Maybe you got your buy orders in before brushing your teeth and putting your nightgown on. Very difficult for an individual to compete in a global market on a 24 hour time frame.  On Thursday, the market rose up as high as 5% above Wednesday’s close, before falling back to a 2.5% gain.

Still, a word of caution.  Both long term Treasuries, TLT, and the SP500, SPY, have been rising since October 2013.

As long as inflation remains low and the Fed continues its zero interest rate policy (ZIRP), long term Treasuries and stocks will remain attractive.   Something has to break eventually.  ZIRP  helps recovery from the aftermath of the last crisis but helps create the next crisis.  Abnormally low interest rates over an extended period are bad for the long term stability of both the markets and the economy.

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Sale – Energy Stocks – Limited Time Only

(Note: this was sent out to a reader this past Tuesday.  Energy stocks popped up 4 – 5% the following day, a bit more of rebound than I expected. The week’s gain was almost 9% and the ETF closed above its 200 week average.)

As oil continues its downward slide, the prices of energy stocks sink.  XLE, a widely traded ETF that tracks energy stocks,  has dropped below the 200 week (four years!) average.  (A Vanguard ETF equivalent is VDE).  Historically, this has been a good buying opportunity. In the market meltdown of October 2008, this ETF crashed through the 200 week average.  A year later, the stock was up 38% and paid an additional 2% dividend to boot.  Let’s go further back in time to highlight the uncertainty in any strategy. The 2000 – 2003 downturn in the market was particularly notable because it took almost three years for the market to hit bottom before rising up again.  The 2007 – 2009 decline was more severe but took only 18 months. In June 2002, XLE sank below its 200 week average.  A year later, the stock had neither gained nor lost value. While this is not a sure fire strategy – nothing is – an investor  is more likely to enjoy some gains by buying at these lows.

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Emerging Markets Stocks

Also selling below the 200 week average are emerging market (EM) stocks.  These include the BRICs (Brazil, Russia, India, China) as well as other countries like Mexico, Vietnam, Turkey, Indonesia and the Philipines. When a basket of stocks is trading below its four year average, there are usually a number of good reasons. Several money managers note the negatives  for EM.   Also included are a few voices of cautious optimism.  Sometimes the best time to buy is when everyone is pretty sure that this is not the right time to buy.  Another blog author recounts two strategies for emerging markets: a long term ten year horizon and a short term watchful stance.  The long term investor would take advantage of the low price and the prospect for higher growth rates in emerging economies.  The short term investor should be cognizant of the fickleness of capital flows into and out of these countries and be ready to pull the sell trigger if those flows reverse in the coming months.

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Welfare

What are the characteristics of TANF families?  When the traditional welfare program was revised in the 1990s, lawmakers coined a new name, Temporary Assistance to Needy Families, to more accurately describe the program.  The old term carried a lot of negative connotations as well. Two years ago Health and Human Services (HHS) published their analysis of a sample of 300,000 recipients of TANF income in 2010.  Although the recession had officially ended in 2009, the unemployment rate in 2010 was still very high, above 9%.  It is less than 6% today.

There were 4.3 million recipients, three-quarters of them children, about 1.4% of the population. By household, the percentage was also the same 1.4% (1.8 million families out of 132 million households).  In 2013, the number of recipients had dropped to 4.0 million, the number of families to 1.7 million (Congressional Research Service)

In 2010, average non-TANF income was $720 per month, or about $170 a week.  To put this in perspective, this was about the average daily wage at that time The average monthly income from TANF averaged $392. Recipients were split evenly across race or ethnic background: 32% were white, 32% black, and 30% Hispanic. For adult recipients only, 37% were white, 33% black, and 24% Hispanic.

Rather surprising was how concentrated the recipients were. 31% of all TANF recipients in 2010 lived in California.  43.3% of all recipients lived in either New York, California or Ohio.  The three states have 22% of the U.S. population and almost 44% of TANF cases.

HHS data refutes the notion that welfare families are big.  50% of TANF families had only one child.  Less than 8% of TANF families had more than 3 children.  82% of TANF families also receive SNAP benefits averaging $378 per month.

In 2014, Federal and State spending on the TANF program was less than $30 billion, about 1/2% of the $6 trillion dollars in total government spending.  The Federal government spends a greater percentage on foreign aid (1%) than the TANF program. Yet people consistently overestimate the percentage of spending on both programs (Washington Post article).  The average estimate for foreign aid? A whopping 28%.  Cynical politicians take advantage of these public misperceptions.

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Omnibus

Aiming to overhaul the health care insurance programs throughout the country, the Affordable Care Act (ACA) was a big bill.  No, it wasn’t 2700 pages as often quoted by those who didn’t like it.  The final, or Reconciled, version of the bill was “only” 900 pages.  The House and Senate versions were also about 900 pages each; hence, the 2700 pages.

At 1600 pages in its final form, the recently passed Omnibus Spending bill makes the ACA look like a pamphlet.  As  specified in the Constitution, all spending bills originate in the House.  Past procedure has been to pass a series of 12 spending bills.  Majority leader John Boehner has found it difficult to get his fractious members to agree on anything in this Congress so all 12 bills were crammed into this behemoth bill just in time to avoid a government shutdown.  Just as with the ACA, most members of the House and Senate did not have adequate time to digest the details of the bill.  The bill is sure to hold many surprises for those who signed it and we, the people, who must live under the farcical law-making of this Congress.  Here is a primer on the budget and spending process.

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Home Appraisals

They’re back!  A review of 200,000 mortgages between 2011 and 2014 showed that 14% of homes had “generous” appraisals, inflating the value of the home by 20% or more.  Loan officers and real estate agents are putting increasing pressure on appraisers to adjust values upwards.

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Personal Income

You may have read that household income has been rather stagnant for the past ten years or more.  In the past fifty years household formation has increased 78%, far more than the 50% increase in population.  The nation’s total income is thus divided by more households, skewing the per household figure lower.  During the past thirty years, per person income has actually grown 1.7% above inflation each year.  Inflation adjusted income is now 66% higher than what it was in 1985.

In 2013, the Bureau of Economic Analysis released median income data for the past two decades. Median is the middle; half were higher; half were lower.  This is the actual dollars not adjusted for inflation.  Except for the recession around the time of 9-11 and the great recession of 2008 – 2009, incomes have risen steadily.

The 3.7% yearly growth in median incomes has outpaced inflation by almost 25%.

Why then does household income get more attention?  A superficial review of household data paints a negative picture of the American economy. Negative news in general tugs at our eyeballs, gets our attention.  The majority of the evening news is devoted to negative news for a reason. News providers sell advertising in some form or another.  They are in the business of capturing our attention, not providing a balanced summary of the news.  In addition, a story of stagnating incomes helps promote the agenda of some political groups.

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Merry Christmas and Happy Chanukah!

Economic Porridge

August 31, 2014

As summer comes to a close and the sun drifts south for the winter, the porridge is not too hot or too cold.

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Coincident Index

The index of Leading Indicators came out last week, showing increased strength in the economy.  Despite its name, this  index has been notoriously poor as a predictor of economic activity.  The Philadelphia branch of the Federal Reserve compiles an index of Coincident Activity in the 50 states, then combines that data into an index for the country.

This index is in the healthy zone and rising. When the year-over-year percent change in this index drops below 2.5%, the economy has historically been on the brink of recession.  The index turns up near the end of the recession, and until the index climbs back above the 2.5% level, an investor should be watchful for any subsequent declines in the index.

As with any historical series, we are looking at revised data.  When this index was published in mid-2011, the percent change in the index was -7% at the recession’s end in mid-2009.  Notice that the percent drop in the current chart is a bit less than 5%.  This may be due to revisions in the data or the methodology used to compile the index.

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Disposable Income

The Bureau of Economic Analysis (BEA) produces a number of annual series, which it updates through the year as more complete data from the previous year is received.  2013 per capita real disposable income, or what is left after taxes, was revised upward by .2% at the end of July but still shows a negative drop in income for 2013.  While all recessions are not accompanied by a negative change in disposable income, a negative change has coincided with ALL recessions since the series began at the start of the 1930s Depression.

Many positive economic indicators make it highly unlikely that we are either in or on the brink of recession.  Clearly something has changed.  Something that has routinely not been counted in disposable personal income is having some positive effect on the economy.  In 2004, the BEA published a paper comparing the methodology they use to count personal income and a measure of income, called money income, that the Census Bureau uses.  What both measures don’t count in their income measures are capital gains.

Unlike BEA’s measure of personal income, CPS money income excludes employer contributions to government employee retirement plans and to private health and pension funds, lumps-sum payments except those received as part of earnings, certain in-kind transfer payments—such as Medicare, Medicaid, and food stamps—and imputed income. Money income includes, but personal income excludes, personal contributions for social insurance, income from government employee retirement plans and from private pensions and annuities, and income from interpersonal transfers, such as child support. (Source)

Analysis (Excel file) of 2012 tax forms by the IRS shows $620 billion in capital gains that year, about 5% of the $12,384 billion in disposable personal income counted by the BEA.  An acknowledged flaw in the counting of disposable income is that the total reflects the taxes that individuals pay on the capital gains (deducted from income) but not the capital gains that generated that taxable income.  Although 2013 data is not yet available from the IRS, total personal income taxes collected rose 16%.  We can suppose that the 30% rise in the stock market generated substantial capital gains income.

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Interest

Every year the Federal Government collects taxes and spends money.  Most years, the spending is more than the taxes collected – a deficit.  The public debt is the accumulation of those annual deficits.  It does not include money “borrowed” from the Social Security trust fund as well as other intra-governmental debt, which add another third to the public debt.  (Treasury FAQ)  This larger number is called the gross debt.  At the end of 2012, the public debt was more than GDP for the first time.

The Federal Reserve owns about 15% of the public debt.  But wait, you might say, isn’t the Federal Reserve just part of the government?  Well, yes it is.  Even the so-called public debt is not so public.  How did the Federal Reserve buy that  government debt?  By magic – digital magic.  There is a lot of deliberation, of course, but the actual buying of government debt is done with a few dozen keystrokes.  Back in ye olden days, a government with a spending problem would have to melt down some of its gold reserves, add in some cheaper metal to the mix and make new coins.  It is so much easier now for a government to go to war or to give out goodies to businesses and people.

Despite the high debt level, the percent of federal revenues to pay the interest on that debt is relatively low, slightly above the average percentage in the 1950s and 1960s but far below the nosebleed percentages of the 1980s and 1990s.

As the boomer generation continues to retire, the Federal Government is going to exchange intra-governmental debt, i.e. the money the government owes to the Social Security trust funds, for public debt.  As long as 1) the world continues to buy this debt,  and 2) interest rates stay low, the impact of the interest cost on the annual budget is reasonable.  However, the higher the debt level, the more we depend on these conditions being true.

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Watch the Percentages

As the SP500 touched and crossed the 2000 mark this week, some investors wondered whether the herd is about to go over the cliff.  The blue line in the chart below is the 10 month relative strength (RSI) of the SP500.  The red line is the 10 month RSI of a Vanguard fund that invests in long term corporate and government bonds.  Readings above 70 indicate a strong market for the security. A reading of 50 is neutral and 30 indicates a weak market for the security. The longer the RSI stays above 70, the greater the likelihood that the security is getting over-bought.

Long term bonds tend to move in the opposite direction of the stock market.  While they may both muddle along in the zone between 30 and 70, it is unusual for both of them to be particularly strong or weak at the same time.  We see a period in 1998 during the Asian financial crisis when they were both strong.  They were both weak in the fall of 2008 when the global financial crisis hit.  Long term bonds are again about to share the strong zone with the stock market.

Let’s zoom out even further to get a really long perspective.  Since November 2013, the SP500 index has been more than 30% above its 4 year average – a relatively rare occurrence.  It happened in 1954 – 1956 after the end of the Korean War, again in December of 1980, during the summer months of 1983, the beginning of 1986 to the October 1987 crash, and from the beginning of 1996 through September 2000.

In the summer of 2000, the fall from grace was rather severe and extended.  In most cases, including the crash of 1987, losses were minimal a year after the index dropped back below the 30% threshold.  When the market “gets ahead of itself” by this much, it indicates an optimism brought on by some distortion.  It does not mean that an investor should panic but it is likely that returns will be rather flat over the following year.

The index rarely gets 30% below its 4 year average and each time these have proven to be excellent buying opportunities.  The fall of 1974, the winter months of 2002 – 2003, and the big daddy of them all, March 2009, when the index fell almost 40% below its 4 year average.

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GDP

The Bureau of Economic Analysis (BEA) released the 2nd estimate of 2nd quarter GDP growth and surprised to the upside, revising the inital 4.0% annual growth rate to 4.2%.  As I noted a month ago, the first estimate of 2nd quarter growth included a 1.7% upward kick because of a build up of inventory, which seemed a bit high.  The BEA did revise inventory growth down to 1.4% but the decrease was more than offset primarily by increases in nonresidential investment. A version of GDP called Final Sales of Domestic Product does not include inventory changes.  As we can see in the graph below, the year-over-year percent gain is in the Goldilocks zone – not strong, but not weak.

New orders for durable goods that exclude the more volatile transportation industries, airlines and automobiles, showed a healthy 6.5% y-o-y increase in July.  Like the Final Sales figures above, this is sustainable growth.

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Takeaways

Economic indicators are positive but market prices may have already anticipated most of the positive, leaving investors with little to gain over the following twelve months.

Sales, Savings and Volatility

August 17, 2014

This week I’ll take a look at the latest retail sales figures, a less publicized volatility indicator, a comparison of BLS projections of the Labor Force Participation Rate, and the adding up of personal savings.

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Retail Sales

Two economic reports which have a major influence on the market’s mood are the monthly employment and retail sales reports.  After a disappointing but healthy employment report this month, July’s retail sales numbers were disappointing, showing no growth for the second month in a row.  The year-over-year growth is 3.7%, which, after inflation, is about 1.5% real growth.  Excluding auto sales (blue line in the graph below), sales growth is 3.1, or about 1% real growth, the same as population growth.

As we can see in the graph below, the growth in auto sales has kicked in an additional 1/2% in growth during this recovery period. Total growth has been weakening for the past two years despite strong growth in auto sales, a sign of an underlying lack of consumer power.

Real disposable income rebounded in the first six months of this year after negative growth in the last half of 2013 but there does not seem to be a corresponding surge in sales.

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Labor Force Projections

While we are on the subject of telling the future…

All we need are 8 million more workers in the next two years to meet Labor Force projections made in 2007 by the Bureau of Labor Statistics (BLS).   8 million / 24 months = 300,000 a month net jobs gained. Hmmm…probably not.  In 2007, the BLS forecast slowing growth in the labor force in the decade 2006 – 2016.  Turned out it was a lot slower. Estimates then for 2016 projected a total of 164 million employed and unemployed.  In July 2014, the BLS put the current figure at 156 million employed.  The Great, or at least Big, Recession caused the BLS to revise their forecast a number of times.  The current estimate has a target date of 2022 to hit the magic 164 million.  In other words, we are 6 years behind schedule.

The Participation Rate is the ratio of the Civilian Labor Force to the Civilian Non-Institutional Population aged 16 and above.  The equation might be written:  (E + UI) / A = PR, where E = Employed, UI = Unemployed and Actively Looking for Work, and A = people older than 16 who are not in the military or in prison or in some institution that would prevent them from making a choice whether to work or not.  As people – the A divisor in the equation – live longer, the participation rate gets lower.  It ain’t rocket science, it’s math, as baseball legend Yogi Berra might have said.

The Participation Rate started rising in the 1970s as more women entered the work force, then peaked in the years 1997 – 2000.  Prior to the recession of 2001, the pattern of the participation rate was predictable, declining during an economic downturn, then rising again as the economy recovered.  The recovery after the recession of 2001 was different.  The rate continued to decline even as the economy strengthened.

In 2007, the BLS expected further declines in the rate from a historically high 67% in 2000 to 65.5% in 2016.  In 2012, the rate stood at 63.7%.  Current projections from the BLS estimate that the rate will drop to 61.6% by 2022.

Much of the decline in the participation rate was attributed to demographic causes in the 2007 BLS projections:

“Age, sex, race, and ethnicity are among the main factors responsible for the changes in the labor force participation rate.” (Pg. 38)

Comparing estimates by some smart and well trained people over a number of years should remind us that it is extremely difficult to predict the future.  We may mislead ourselves into thinking that we are better than average predictors.  Our jobs may seem fairly secure until they are not; a 5 year CD will get about 5 – 6% until it doesn’t; the stock market will sell for about 15x earnings until it doesn’t; bonds are safe until they’re not.

The richest people got rich and stay rich because they know how unpredictable the world really is.  They hire managers to shield them – hopefully – from that unpredictability.  They fund political campaigns to provide additional insurance against the willy-nilly of public policy.  They fight for government subsidies to provide a safety cushion, to offset portfolio losses and mitigate risk.  What do many of us who are not so rich do to insure ourselves against volatility?  Put our money in a safe place like a savings account or CD.  In real purchasing power, that costs us 1 – 2%, the difference between inflation and the paltry interest rate paid on those insured accounts.  In addition, we can pay a hidden “insurance” fee of 4% in foregone returns by being out of the stock and bond markets.  We stay safe – and not-rich.  Rich people manage to stay safe – and rich – by not doing what the not-rich people do to stay safe.  Yogi Berra couldn’t have said it better.

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China

For you China watchers out there, Bloomberg economists have compiled a monetary index from several key factors of monetary policy.  After hovering near decade lows, China’s central bank has considerably loosened lending in the past two months.  The chart shows the huge influx of monetary stimulus that China provided in 2009 and 2010 as the developed world tried to climb up out of the pit of the world wide financial crisis.

The tug of war in China is the same as in many countries.  Politicians want growth.  Central banks worry about inflation.  The rise in this index indicates that the central bank is either 1) bowing to political pressure, or 2) feels that inflationary pressures are low enough that they can afford to loosen the monetary reins.  As is often the case with monetary policy, it is probably some combination of the two.

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Personal Savings Rate

Over the past two decades, economists have noted the low level of savings by American workers.  While economists debate methodologies and implications, politicians crank up their spin machines. More conservative politicians cite the low savings rate as an indication of a lack of personal responsibilty.  As workers become ever more dependent on government programs, they do not feel the need to save.  Over on the left side of the political aisle, liberals cite the low savings rate as a sign of the growing divide between the middle class and the rich.  Many families can not afford to save for a house, or their retirement, or put aside money for their children’s education.  We need more programs to correct the economic inequalities, they say.

While there might be some truth in both viewpoints, the plain fact is that the Personal Savings Rate doesn’t measure savings as most of us understand the term.  A more accurate title for what the government calls a savings rate would be “Delayed Consumption Rate.”  The methodology used by the Dept. of Commerce counts whatever is not spent by consumers as savings.  “To consume now or consume later, that is the question.”

If a worker puts money into a 401K each month, the employer’s matching contribution is not counted.  If a consumer saves up for a down payment for a house, that is included in savings.  When she takes money out of savings to buy the house, that is a negative savings.  The house has no value in the “savings” calculation.  Many investors have a large part of their savings in mutual funds through personal accounts and 401K plans at work.  Capital gains in those funds are not counted as savings.  (Federal Reserve paper) In short, it is a poor metric of the aggregate behavior of consumers.  Some economists will point out that the savings rate indicates a level of demand that consumers have in reserve but because a significant portion of saved income is not counted, it fails to properly account for that either.

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Volatility – A section for mid-term traders

No one can accurately predict the future but we can examine the guesses that people make about the future.  In his 2004 book The Wisdom of Crowds (excerpt here) James Surowiecki relates a number of studies in which people are asked to guess answers to intractable problems, like how many jelly beans are in a jar.  As would be expected, respondents rarely get it right.  The surprising find was that the average of guesses was remarkably close to the correct answer.

Through the use of option contracts, millions of traders try to guess the market’s direction or insure themselves against a change in price trend.  A popular and often quoted gauge of the fear in the market is the VIX, a statistical measure of the implied volatility of option contracts that expire in the next thirty days.  When this fear index is below 20, it indicates that traders do not anticipate abrupt changes in stock prices.

Less mentioned is the 3 month fear index, VXV (comparison from CBOE). Because of its longer time horizon, it might more properly be called a worry index.  Many casual investors have neither the time, inclination or resources to digest and analyze the many economic and financial conditions that impact the market.  So what could be easier than taking a cue from traders preoccupied with the market?  Below is a historical chart of the 3 month volatility index.

Historically, when this gauge has crossed above the 20 mark for a couple of weeks, it indicates an elevated state of worry among traders.  The 48 month or 4 year average of the index is 19.76.  Currently, we are at a particularly tranquil level of 14.42.

When traders get really spooked, the 10 day average of this anxiety index will climb to nosebleed heights as it did during the financial crisis.  As the market calms down, the average will drift back into the 20s range, an opportunity for a mid-term trader to get cautiously back into the water, alert for any reversal of sentiment.

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Takeaways

Retail sales have flat-lined this summer but y-o-y gains are respectable.  So-so income growth constrains many consumers.  The 3 month volatility index is a quick and dirty summary of the mid-term anxiety level of traders.  A comparison of BLS labor force projections shows the difficulty of making accurate predictions.  The personal savings rate under-counts savings.

Follow The Money

June 14th, 2014

This week I’ll take a look at some near-term trends in small business, labor, oil and housing and a few long-term trends in income and debt.

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Small Business

Huzzah, huzzah!  The monthly survey of small business owners by the National Federation of Independent Businesses (NFIB) broke through the 96 level after cracking the 95 level last month.  Sentiment has not been this good since mid-2007.  Hiring plans have been on the rise for the past several months and owners are reporting rising sales.

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JOLTS (Job Openings and Labor Turnover Survey)

The Job Openings report from the Bureau of Labor Statistics (BLS) has a one month delay so the data released this past week was for April.  The number of job openings was 40,000 higher than expected, coming in close to 4.5 million.  As a percent of the workforce, job openings are approaching pre-recession highs.

The decline in construction job openings is a disappointment.  We are near the same level as 2003, a weak year of economic growth.  We should expect to see an uptick in job openings in next month’s report, confirming that projects put on hold during the severe winter in the eastern part of the country are again on track.  Further declines would indicate a spreading malaise.

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Gross Domestic Income

On a quarterly basis Gross Domestic Income, GDI, and Gross Domestic Product, GDP, differ somewhat but over the long run closely track each other.  Following up on two previous posts on Thomas Piketty’s book Capital in the 21st Century, I wondered what percent of GDI goes to pay employee compensation.  As we can see in the chart below, total compensation for human labor has been dwindling to post WW2 levels.

This is total compensation, including benefits.  Wage and salary income as a percent of total national income has declined steadily.

As a percent of total income, employee benefits have more than tripled since the end of World War 2 and now comprise more than 10% of the country’s income.

Demographic shifts have contributed to the decline of labor income.  The post war boomer generation, 80 million strong and 25% of the population, contributes to the trend as they save for retirement. As capital gains, interest and dividend income increase, this reduces the share of wage and salary income.

Economic changes have been a major factor in the decline of labor income.  Capital investments in technology, both in hardware and software, have reduced the need for labor for a given level of production.  Capital investment demands income to pay back the investment. For most of the 20th Century, machines replaced human muscle in farming, manufacturing and construction.  In the past two decades, machines are increasingly replacing mental muscle.

How we count labor income has changed.  Tax law changes in 1986 and 1993 reduced the amounts that are included as compensation but the overall effect of these changes is relatively minor.

If we divide the country’s total employee compensation by the number of employees, we might ask “What recession?”  Average annual compensation has climbed from $38-54K in a dozen years.  That’s almost a 50% raise for every employee!

Of course, everyone has not had a 50% increase in income over the past 12 years.  Human capital, the educational and technical training that an employee has to offer, has earned an increasing premium in the past three decades. Those with more of this capital have captured more benefit from the dwindling pool of labor needed for the nation’s production.

Average disposable income tells a more accurate story of the majority of people in this country.  Disposable income is what’s left over after taxes.  The trend is downward.

How do we cope with flat income growth?  Charge it!  It’s the Amurikin way! Per capita Household Debt has increased 75% in the past 13 years.  After a decline from the rather high levels before the recession began in late 2007, per capita debt has leveled off in the past two years.

Rising house prices and stock market values have increased net worth.  As a percent of net worth, household debt has declined to the more sustainable levels of the 1990s.

The percentage of disposable income needed to service that debt is at thirty year lows, meaning that there is room for growth.

In response to the hostilities in Iraq, oil prices have been on the rise.  Historically, a rise in oil prices leads to a rise in prices at the pump which takes an extra bite out of disposable income and puts a damper on consumer spending growth.

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Oil Prices

A blog by Greg McIsaac at the Washington Monthly in May 2012 presents an interesting historical summary of oil prices and production.  The American love of simplicity leads many to credit one man, the President, for the rise and fall in gasoline prices, although the President has little, if any, influence on oil pricing. McIsaac notes The combination of lower energy prices and increased energy efficiency in the 1980s reduced US expenditures on energy by nearly 6 percent of GDP.  Deregulation of energy prices begun under the Carter Administration were largely credited to the Reagan administration.   He writes “crediting Reagan with falling energy prices of the 1980s exaggerates the roles of both Reagan and deregulation and obscures the larger influence of conservation and increased production outside the US.”  Production actually fell for several years after regulatory controls were lifted.

Further increases in oil prices will no doubt be blamed on this President.  The one thing that each outgoing President bequeaths to the newcomer before the inauguration is the Presidential donkey suit.

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Housing

Redfin Research Center reports a sharp decline in the number of houses sold through May. After a 7.6% year-over-year decline in April, home sales slid 10% from May 2013 levels.  Real estate agents are reporting a shift from a seller’s market to a buyer’s market.

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Takeaways

Small business accounts for approximately 60% of new jobs and optimistic sentiment among small business owners is growing.  The labor market continues to show continuing strength in the number of job openings and a decline in new unemployment claims.  Disposable income growth is flat but the portion of income needed to service debt is very low.  Rising oil prices and a slowing housing market will crimp economic growth.
Next week I’ll look at a complex topic – is the stock market fairly valued?  

Piketty Pushes Back

June 1st, 2014

First a shout out to our friends in the southern hemisphere where the winter is beginning in earnest.  Hey, you had the sun for six months.  Now it’s our turn.  We all have to share.  I think that because there are more people in the northern hemisphere, the sun should stay up here for longer than six months.  It’s not fair.

Piketty Controversy

Talking about fair…..Last week I touched on some of the highlights in Thomas Piketty’s book, Capital in the 21st Century.  At the time of that writing, Chris Giles in the Financial Times had just reported that he found some data errors while using Piketty’s source material.  Giles’ criticisms were rather precise and included charts of the revised data which Giles claimed contradicted Piketty’s conclusions that wealth inequality had risen during the past thirty years.  This past Friday, the financial site Bloomberg reported that Piketty had rebutted criticisms of his methodology.  En garde!!! For those of you who are not interested in the minutiae of the disagreements, I will quote from Piketty’s response:

What is troubling about the FT methodological choices is that they use the estimates based upon estate tax statistics for the older decades (until the 1980s), and then they shift to the survey based estimates for the more recent period. This is problematic because we know that in every country wealth surveys tend to underestimate top wealth shares as compared to estimates based upon administrative fiscal data. Therefore such a methodological choice is bound to bias the results in the direction of declining inequality.

Piketty’s rebuttal is sound but the debate over data and methodology does underscore a problem. There were times when I have questioned Piketty’s data only to find that he addressed those concerns in either the footnotes to the book or in notes contained in his tables.   Fearing that I might put readers to sleep, I edited out of last week’s blog a concern I had with Piketty’s rate of inflation shown on page 448 when he presented a table – Table 12.2 – of historical returns by university endowments.  Piketty states a 2.4% inflation rate from 1980-2010, which struck me as too low (BLS figures are 3.3%).  In a note at the bottom of the Excel file TS12.2, he revealed that he used the GDP deflator, not the CPI, in order to keep data consistent with the GDP series.  He could have stated this simply at the bottom of the table in the book.  It’s not like the publishers were trying to save space in a 700 page book.

So, Open Letter to Professor Piketty and other Economists:  Please put your caveats and clarifications up front and center and repeat often. Last week, I gave several examples of Piketty’s clarifications which could be found in a referenced paper or on one of the spreadsheets that his team compiled.  James Joyce famously said of his book Finnegan’s Wake that he expected the reader to put as much time and effort in reading the book as Joyce did in writing the book.  Relatively few people have read Finnegan’s Wake.  Help us understand your point!!

For those of you who want more of the controversy, a reader sent me this, including  Simon Wren-Lewis’s comments on the matter at Mainly Macro, which I link to every week on the side of this blog. Economist Tyler Cowen comments echo my concerns with valuations of capital that vary widely because of asset pricing.  When an asset is difficult to price or varies widely in price, should one use the SNA international convention (System of National Accounts) and estimate a present value based on projected future flows?  The founder of Vanguard, John Bogle, recommends this common sense approach for our personal portfolios; that we should stop looking at our statements and look at the money flows that our portfolio mix will probably generate them when we need them.  That is the true worth of our portfolios, according to Bogle – not some temporary valuation based on the market prices on the last day of the month.

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What is Income?

This week, as I listened to and read discussions of income in the U.S., it became apparent that there are understandable misconceptions of what is being counted when economists tally up the income of a household and the income of a nation.  Update:  Corrected. A 2011 report from the Census Bureau states that household income does include cash benefits before taxes.  EITC payments are not included because they are a reverse tax (Source).  Non-cash benefits like Medicaid, Food Stamps and housing assistance are not included.  These non-cash benefits can easily surpass $1000 per month.

Money income includes earnings, unemployment compensation, workers’ compensation, Social Security, Supplemental Security Income, public assistance, veterans’ payments, survivor benefits, pension or retirement income, interest, dividends, rents, royalties, income from estates and trusts, educational assistance, alimony, child support, cash assistance from outside the household, and other miscellaneous sources.

The national income figures that Thomas Piketty uses in his book do include government transfers.  The 2005 NIPA Guide summarizes what is included in personal income.   IVA and CCAdj are inventory and depreciation adjustments.

Personal income is the sum of compensation of em­ployees, received; 
proprietors’ income with IVA and CCAdj; 
rental income of persons with CCAdj; 
personal income receipts on assets; 
and personal current trans­fer receipts; 
less contributions for government social insurance

Measuring income to determine an aggregate level of well-being within the population is challenging and gives each side ample ammunition in the political debate.  The inclusion and exclusion of various types of benefit, cash and otherwise, leads one side to dismiss the conclusions of the other side and hinders a constructive dialog.

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GDP Growth

Each month the BEA (Bureau of Economic Analysis) releases a new estimate of the previous quarter’s GDP.  This past week the BEA released the 2nd estimate of 1st Quarter GDP growth, showing an annualized 1% decline.  This was pretty much in line with consensus estimates and the market’s response was rather neutral on the day of the release.  Much of the downturn was ascribed to the particularly harsh winter weather and many economists are projecting a 4% annualized increase in this quarter, a rebound to offset the past quarter’s decline.

Peering under the hood of the GDP report:  under the category of Private Domestic Investment, residential housing dropped almost 8% (annual rate) in the fourth quarter and another 5% in the first quarter of 2014.  What is more surprising is the almost 2% drop in business investment.  Let me go back to a paper by Ed Leamer that I first wrote about in February.  Mr. Leamer’s thesis is that the sales of new homes first decreases, followed by a decrease in business investment. He found that this 1-2 punch precedes most recessions by about 3 – 4 quarters.  In two cases, it was a false positive.  Perhaps this latest 1-2 punch  is a false positive.  Perhaps it was just the winter weather.  This economy does not feel like a recession is at all imminent. Industrial activity, the labor market and auto sales are strong or expanding. More perplexing to a casual investor might be a summer lurch downward in the market if the economy does not show signs of a correcting rebound.

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Fixed Capital Consumption

Since 2000, there has been a notable change in economic growth.  It is not often that we see growth above 3% as we did in the 20th century.

Helping that meager growth rate look – well, less meager – is an item that the BEA adds to GDP called Fixed Capital Consumption.  To the ordinary Joe, this is simply depreciation, but this is not the depreciation that your accountant might have mentioned if you own a small business or rent out part of your home. The depreciation that the BEA calculates is based on the current market price of a piece of equipment, for example, not the actual cost of the item.  As an example, let’s say that Billy and Betty Jones bought a new $20,000 truck for their business and their accountant depreciates it over a 5-year cycle.  To keep it simple, assume that the truck’s depreciation each year is 20%.  That depreciation is based on the cost of the vehicle.  Let’s do it the way the BEA does it (if only!  The IRS does not allow this!).  In year 3, the current market price of a similar vehicle is $24,000.  20% of $24,000 is $4800, higher than the $4000 depreciation based on the cost of the vehicle. In a given year, the amount of depreciation actually reported by companies might be $2 trillion.  The BEA figure will be higher and this is included in Gross Domestic Product.  As a percentage of GDP, depreciation has risen considerably since the early 2000s, driving up reported GDP growth just a smidge.  Below is a chart of the increasing percentage of GDP that is Fixed Capital Consumption.  Almost one of every six dollars of GDP is being allocated to depreciation, a third higher than 1960 rates.

In a low inflation environment, the change in the market prices of equipment and land is muted.  Are capital expenditures becoming obsolete at a faster pace?  Over the past two decades, software and systems development has become an increasing share of non-residential investment.  Rapid changes in technology may be one driver of the acceleration in depreciation.  Wikipedia has a good article on the concept as it is reported in the national accounts.

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Education

As I mentioned last week, I’ll look at a paper I read recently which had some rather startling conclusions. In a paper published in the World Economic Review earlier this year, economists James Galbraith and J. Travis Hale reviewed paycheck and IRS income data to identify state and national trends in income inequality during the past 40+ years.  It comes as no surprise that there is inequality between sectors in the economy, a fact which Galbraith and Hale acknowledge.  Their particular focus was the changes in inequality within and between sectors at the state and national levels.

There are two components to income inequality: 1) wage growth or the lack of it; and 2) employment growth or the lack of it within each sector.  If a particular sector experiences a period of high growth in earnings but jobs decline in that sector, then the gains become more concentrated and inequality between sectors grows.

What Galbraith and Hale found was that the changes in the 1990s and 2000s had one common characteristic: booming sectors of the economy vs. non-booming sectors accounted for most of the growth in income inequality.  Where each decade differed was the change in the sectors that experienced high growth.  The 1990s was marked by a growth spike in information technology, giving rise to out-sized gains to workers in the professional, scientific, and technical fields.   The 2000s was the decade of outsized growth in construction, defense and extractive technologies. Here is a troubling finding of their study: common to both periods is that the number of jobs declined in those sectors that experienced high wage growth.  Higher pay = less job growth. Also common to both decades, until the financial crisis in 2008, was the high growth in the finance and insurance industries.  Problem:  Rising  inequality.  Remedy: More education. The authors acknowledge this common response:

When public discourse admits inequality to be a problem, education is often given as the cure.  According to Treasury Secretary Henry Paulson (2006), for instance, the correct response to rising inequality is to “focus on helping people of all ages pursue first-rate education and retraining opportunities, so they can acquire the skills needed to advance in a competitive worldwide environment.”  This is a view with powerful support among economists. 

But their evidence casts this common conception into doubt:

As we’ve shown, the last two decades have seen significantly slower job growth in the high-earnings-growth sectors than in the economy at large. So even if large numbers of young people do “acquire the skills needed to advance” there is no evidence that the economy will provide them with jobs to suit.  Many will simply end up not using their skills.  Moreover, a strategy of investment in education presupposes advance knowledge of what the education should be for. Years of education in different fields are not perfect substitutes, and it does little good to train too many people for jobs that, in the short space of four or five years, may (and do) fall out of fashion. And experience shows clearly that the population does not know, in advance, what to train for. Rather, education and training have become a kind of lottery, whose winners and losers are determined, ex post, by the behavior of the economy.

Does this mean that parents and grandparents should cash in those college funds for the kids and take a long vacation with the money?  Hardly.  Bureau of Labor Statistics reveal that those with a college education have a significantly greater lifetime income than those without. The findings of this paper imply, however, that the economy and the job market change in ways which none of us can reliably predict.  The wiser course for students might be the same advice financial advisors give to investors: diversify.  If a student is majoring in philosophy, take some business, computer or science courses. Science majors could do with some literature and writing courses as well.

At the start of the 20th Century, 40% of the population was engaged in farming-related jobs.  A century later, less than 2% of jobs are in the agricultural sector.

When I was a teenager, an aunt told me that a reliable bookkeeper could always find a job. That was before the introduction of the computer and accounting programs for small businesses.

The number of librarians has declined about 10% in less than a decade.  In 1990, who could have predicted that?

Records Management, once a clerical job, has evolved into management of many interdependent mediums, complicated by laws and regulations that few could foresee just twenty years. A science major confident in the availability of work in a certain skilled profession might find that the introduction of a qubit computer in 2025 sharply reduces jobs in that profession.

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Takeaway

As investors, we often think that we can avoid the pain so many of us experienced in 2008 if we pay more attention to economic and corporate indicators.  In hindsight, the graphed data looks so obvious. We ignore now what we didn’t ignore then because we know now what to ignore, making hindsight a marvel of clarity.  The future enables us to filter out the noise of the past.

If China’s housing sector implodes and repercussions of that undermine the U.S. economy, we’ll criticize ourselves for not reading that article on page 24 that detailed the coming crisis.  There will be a graph of some spread in interest rates or some other indicator that we glossed over at the time.  If there is a recession 9 months from now (this is just an ‘if’), we will forget the harsh winter of 2014 that blinded us to the early warning signs.  We will see the decline in 1st quarter GDP together with the decline in disposable personal income as the clearest of warning signs and slap ourselves on the head for missing it.  Some guy will get on the telly and show us how he predicted it all along and we’ll think that we should get his newsletter because this guy knows.

As to our current disputes, the grandchildren of our grandchildren may be puzzled by our concerns with income and wealth inequality.  We remember the first two paragraphs of the Declaration of Independence, which the signers largely agreed to with a few revisions.  The majority of the Declaration is concerned with a list of grievances against the British Empire, which the signers debated vigorously, making numerous amendments to the text.

When did we last have a debate on which metal, gold or silver, should serve as a backing to the currency?  This burning topic of the late 19th Century is of little more than historic interest.

Over a fifty year period in the 19th Century, bankruptcy became less a criminal act and more a civil matter, culminating in the Nelson Act in 1898 which codified our more modern notion of bankruptcy.

With relatively little debate, 19th Century Americans bequeathed their heirs a country dominated by large corporations.  Less by design and more by default, the raising of private capital by corporations seemed to be a convenient solution to the persistent misuse of public funds by corrupt politicians in that century.

We no longer argue, as they did during the Civil War, whether the Federal Government has a responsibility to bury soldiers who have died on the battlefield.

We argue about guns and the meaning of the Second Amendment, which 19th Century Americans thought was non-controversial and not a universal individual right to gun ownership.

A hot topic of debate in the early part of the 20th Century was whether Irish, Italians and other Southern European immigrants were fully evolved humans and were capable of exercising the right to vote.

19th Century Americans argued about the moral validity of slavery.  We don’t.

What is the minimum working age for children?  Is it six or eight years of age?  What should be the legal maximum hours that they can work?  These burning questions of the early 20th Century are dead embers now.

The issues changes, our perspectives change, but we can be sure of one thing: in a hundred years, we will still be arguing as much as we do today and that is oddly reassuring.